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TERs tell you the exact cost of owning a fund

I know, I know. MER means zzz to many of you readers.

Consider this snooze factor noted as the brand new sibling of the management expense ratio, or MER, is introduced. It's called the trading expense ratio, or TER, and it finally gives us investors a way of telling exactly how much it costs to own our mutual funds.

MERs are a way of saying how much of the money in a fund is going to pay almost all the various operational and managerial costs. If a fund's MER is 2.5 per cent, it's like saying that these costs are eating up 2.5 percentage points in returns each year.

The problem with the MER is that even after you scoop out those 2.5 percentage points, you still haven't quite pinned down how much you're paying.

The missing bit of information here is the amount of brokerage expenses incurred by a fund in trading stocks -- for accounting reasons, they are not lumped into the MER.

Fund companies have reported the dollar amount they spent on trading expenses, but this is meaningless to investors. To really explain how much a fund is spending on brokerage costs, you need a trading expense ratio that works like the MER.

Now we have one and you'll see it in action as you peruse the communications your fund companies send in the coming months to describe their exploits in 2005.

As a result of expanded disclosure requirements recently introduced by provincial securities commissions, fund companies must now report a TER as well as an MER. Add these two numbers together and you have the bottom line on what it costs to own a mutual fund.

Let's take the Acuity Income Trust Fund as an example. Its MER in 2005 was 2.75 per cent and its trading expense ratio was 0.29 per cent. Add up the two ratios and you have a fund where 3.04 per cent of the assets go to pay fees to investment advisers, operational costs, managerial costs and, of course, brokerage costs.

That seems high, but this fund has been an absolute stud since it opened for business three years ago. Anyway, at least unitholders now know that the first 3.04 per cent of returns generated by the fund go to Acuity and not to them.

Trading expense ratios can be found in the annual and semi-annual reports on fund performance that fund companies must now issue. You'll find them on the Financial Highlights page listed under Ratios and Supplemental Data. How soon you start seeing TER numbers depends on the year-end for your funds. Most funds have a Dec. 31 year-end, which means fund companies will be issuing annual reports with TER numbers in the months ahead if they haven't already done so.

Already, we're seeing different levels of TER disclosure. Acuity's annual management report of fund performance for 2005 shows a ratio for the past year but leaves out numbers for 2004 and 2003. "The trading expense ratio is a new requirement and is provided from 2005 onwards," the company says.

Over at BMO Investments, they've put a little more effort into meeting the new disclosure requirements by showing the trading expense ratio for each of the past five years. So when you look at the annual management report of fund performance for BMO Dividend, you'll know that the minuscule 2005 TER of 0.05 per cent was no fluke.

Combine this with the MER of 1.75 per cent last year and you have an all-in fee burden of 1.8 per cent, which is quite reasonable for a fund that has outperformed the S&P/TSX composite total return index five by percentage points over the past 10 years.

The new mutual fund disclosure requirements will also give investors a more detailed written summary of how their funds are doing on a semi-annual basis, plus quarterly updates on the top 25 holdings in a fund. Funds also have to say how they vote the shares they control through their portfolio holdings.

There's been some whinging from the fund industry about these new measures and one star manager, Tom Stanley of the Resolute Growth Fund, has taken the rather extreme step of announcing he will shut down his fund rather than disclose his top holdings. From the investor's point of view, though, all of the new information is a big win.

If you like to take a fund apart before investing in it, then you now have more tools with which to do this. And if you want to know how much you're paying to own your mutual funds, now you can find out the exact amount by adding the new TER to the trusty old MER. By the way, MER + TER = $$$, not zzz.

© 2007 The Globe and Mail. All rights reserved.

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